With all the cold weather that has hit the East Coast of the US, even here in the usually temperate South, it has taken little to shift my thoughts to warmer climes and warmer times. That tendency has been exaggerated by the presence in my inbox each week of ridiculously cheap deals on cruises. As a past client of all three major US listed cruise companies, Carnival (CCL), Royal Caribbean (RCL) and Norwegian (NCLH), I receive promotional e-mails from all of them.
Carnival, in particular, has been cutting prices aggressively. I could, apparently, cruise for 7 days for around $57 per day. Once you factor in heating my house and three meals a day, it may work out cheaper than staying at home. This week we learned that rival Norwegian has been forced to respond and is likely to feel the pinch. All of this is great news for me as a consumer, but what does it mean for investors?
2013 was a tough year for cruise ship operators and so far this year hasn't looked much better. It seems that every time you turn on the TV there is some story of “...the cruise from hell” or something like it. Grumpy passengers coming off of cruise ships that have suffered mechanical problems or outbreaks of sickness have become commonplace. Stock in the sector as a whole has underperformed the market slightly, but that obscures huge differences between the different companies' performances.
Carnival (CCL), the largest operator and the one with the most problems, has seriously lagged the overall market with shares increasing only 3.64% since the end of 2012, while at the other end of the spectrum, Royal Caribbean (RCL) has jumped over 51% in that time. Norwegian (NCLH), that IPO'd in late January of 2012 has roughly kept pace with the S&P 500 since then.
My natural inclination is to look first at the weakest stock, on the basis that that is where the value is most likely to be found, but for now CCL may be best left alone. The damage to their reputation that repeated problems last year did may well take some time to get past.
The company's insistence, following the onboard fire on the Carnival Triumph last February, that the contract that passengers sign "...makes absolutely no guarantee for safe passage, a seaworthy vessel, adequate and wholesome food, and sanitary and safe living conditions" may have been legally correct, but it hardly inspired a rush to book with them. Given that ongoing reputational damage, a forward P/E of over 16 for CCL looks anything but cheap.
The question, of course, is how much Carnival's woes have impacted their rivals. Until this week it seemed that NCHL, in particular, was avoiding the pressure. They had maintained double digit pricing premiums with new fleet additions and a “classier” image, but in a call following their Q4 earnings on Tuesday, management suggested that those days are over. The stock reacted accordingly, dropping around 5% in a flat market.
If we look at what was actually said, however, it appears that that reaction may just offer some value. While they acknowledged pricing pressure, NCLH management didn't make any major adjustments to their forward guidance. In other words they are confident of their ability to ride the storm, if you'll forgive the phrase.
The new vessels mentioned above come at a price, of course, and for some the level of leverage implied in a debt to equity ratio of 121 may be off-putting. I can understand that, but even as the Fed tapers, forward guidance is keeping rates low and cruise lines, like most leveraged sectors, have some degree of rate sensitivity priced in.
If it is too troubling, you may prefer the last of the big three, RCL. Royal Caribbean is less leveraged than NCLH and is the only one of the major lines currently reporting positive free cash flow. Despite this, RCL is still reasonably priced at a comparable forward P/E to NCLH of just over 12.
For these reasons, even given significant appreciation in the last quarter of last year, RCL would be my pick of the three, but any investment in the sector involves monitoring a couple of things. As I said above, these companies are highly leveraged, so interest rates should be watched as any significant rise would have a negative impact.
For me, a more worrying scenario, though, would be if oil prices consolidate above $100/barrel to put long term pressure on fuel pricing. In a world where margins are being squeezed that would present an obvious problem, but I think a drop back in oil toward the mean is more likely in the coming weeks. All the same, if you do decide to take a chance on NCLH, keep an eye on NYMEX WTI pricing.
The cruise line business has had some problems over the last few years, in many cases self-inflicted. The damage done to Carnival may take some time to repair, but both of their rivals look like reasonable investments. If nothing else, thinking about cruising the Caribbean is a pleasant thing to do after the winter that most of us have had.